In many markets, buy and sell orders at the same price are automatically matched. Thus, for example, a first order to buy an item at a price of 100 and a second order to sell the same item at a price of 100 will, in such markets, result in a transaction in which some quantity of the item is sold at the specified price.
But in some markets, most notably the secondary market for U.S. government treasuries, orders of equal price are not automatically matched. Rather, certain types of buy and sell orders, called “passive” orders, may co-exist at the same price without triggering a transaction. These passive orders do not trade unless “aggressed” against by a trader submitting a second type of order, called an “aggressive” order. Historically, a passive order to buy has been referred to as a “bid,” while a passive order to sell has been referred to as an “offer.” By contrast, an aggressive order to sell has been referred to as a “hit,” while an aggressive order to buy has been referred to as a “take” or “lift.”
This distinction between passive and aggressive orders is one of several characteristics of the secondary market in U.S. government treasuries that developed to encourage market liquidity. In particular, since it is impossible to generate liquidity in a market without having someone first make a price, inter-dealer brokers historically sought to encourage traders to submit bids and offers by not charging them a commission if their orders resulted in a trade. Thus, passive bids and offers could not be matched even at the same price since neither the passive buyer nor the passive seller would be required to pay a commission and the inter-dealer broker would not execute a transaction without a commission being paid.
In addition to commission-free trades, inter-dealer brokers in the secondary market for U.S. government treasuries also rewarded buyers and sellers by developing a number of trading protocols or conventions which granted certain buyers and sellers certain trading options or “rights.” One such convention is commonly referred to as “workup.” In general terms, this convention permits buyers and sellers to “work up” the size of a trade from the quantity traded as a result of an initial “hit” or “lift.” Historically, certain traders, including the first aggressive-side and passive-side traders, were granted an option or right to increase their size, and to trade that additional size ahead of other traders.
Conceptually, a workup is considered a single deal extended in time. This conception was reflected historically in several interesting aspects of workup trading. For example, because all trading during workup was considered part of a single deal, all such trading occurred at a single price point set by the initial hit or lift that triggered the workup. In addition, the initial aggressor's side of the market (i.e., the sell side in the case of a hit and the buy side in the case of a lift) was designated the “aggressive” side of the market for the duration of the workup. Similarly, the opposite side of the market was designated the “passive” side of the market for the entire workup. This designation played an important role in trading, including determining which entities would pay commission, historically paid only by the aggressive side of the market.
As electronic trading developed, electronic platforms were developed that provided for automated workup functionality. One such electronic platform is the BrokerTec® electronic trading platform operated by ICAP Electronic Broking which first included a workup functionality in May 2001. As originally launched, the BrokerTec workup functionality included two distinct phases, a private phase and a public phase. During the private phase, an aggressor that bought or sold all displayed volume at the best available price was granted an exclusive right to trade additional volume for the duration of the private phase. If the aggressor failed to buy or sell all displayed volume at the best available price, no exclusive trading privileges were granted on the aggressive side of the market, and all traders on that side of the market traded on a first-come-first-served basis even during the private phase. On the passive side of the market, the first position bidder or offeror that was hit or lifted was granted exclusive trading privileges for the duration of the private phase.
The private phase in the BrokerTec electronic trading platform automatically expired after a fixed, non-extendable number of seconds tracked by a timer. Upon expiration of the private phase, the public phase commenced. During the public phase, all trading on both sides of the market was conducted on a first-come-first-served basis. The duration of the public phase was also controlled by a timer. But unlike the private-phase timer, the public-phase timer was reset each time a new execution occurred during the workup. Thus, expiration of the public-phase timer indicated a sustained period of trading inactivity and caused the system to end the workup.
The BrokerTec electronic trading platform includes three types of aggressive orders: fill or kill (FoK), fill and store (FaS), and fill and kill (FaK). Generally speaking, a FoK order is executed only if it can be completely filled. Thus, for example, if a trader submits a FoK order to buy $10M of a particular security at par and only $8M of that security is available at that price, no trade occurs and the order is “killed,” i.e., not entered in the order book.
By contrast, FaK and FaS orders may be partially filled. When a FaS order is partially filled, the unfilled portion of the order is automatically converted to a new order for the unfilled size on what is called the “follow,” i.e., the period following completion of the trade. Thus, if a trader submits a FaS order to buy $10M of a particular security at par and only $8M of that security is available at that price, $8M of the order is filled, and the unfilled portion of the order is converted into a new passive order to buy $2M of the specified security at par.
When a FaK order is partially filled, the unfilled portion of the order is “killed” and does not result in an order for the unfilled size on the follow. Thus, if a trader submits a FaK order to buy $10M of a particular security at par and only $8M of that security is available at that price, $8M of the order is filled, and the order's unfilled portion is “killed.”